1. Field of the Invention
A method and system for converting an annuity fund to a life insurance policy at a predetermined conversion date.
2. Description of the Prior Art
Annuities and life insurance are designed to meet different specific financial planning objectives. Since the Internal Revenue Code can have a significant impact on the realization of a person's particular goals, tax consideration of the tax consequences in the selection and purchase of annuities and/or life insurance is often a compromise.
Investment income from the cash values inside the annuity appreciates on a tax deferred basis. Such annuities have no death benefit other than the return of the current account value. Thus, none of the premium for the annuity is invested in current mortality costs. Except for any costs and fees, the entire annuity deposit is available to earn investment income.
Distributions of the investment income to the annuitant are taxed as ordinary income. Upon death, the proceeds of the annuity are income in respect of a decedent and taxed as ordinary income to the estate.
On the other hand, variable universal life insurance policies that qualify under Section 7702 of the U.S. Internal Revenue code have significant tax benefits. In order to qualify within the IRC, not only must the investment meet the diversification requirements identical to the diversification requirements for annuities, but the death benefit in relationship to the premium deposit must first satisfy the Guideline Single Premium (GSP) requirement as statutorily mandated. Otherwise the policy will not qualify as a life insurance policy under Section 7702. The GSP defines maximum premium payable with respect to the initial death benefit. In addition, a cash value corridor that varies by age, between the face amount and the account value must be maintained at all time.
The difference between the initial face amount, as determined by the GSP, and the initial account value is the amount of the mortality insurance established at the time of automatic conversion to the life insurance policy. Since the cash value corridor decreases by age, the required Face Amount in relationship to the account value decreases. Therefore the mortality element as required by Section 7702 decreases as the age of the applicant increases.
To the extent the assets of the life policy are used to purchase mortality insurance, such assets are not available for investment purposes. The younger the person is that is proposed to be the insured life, the greater impact this concern will have on the decision to purchase the life policy.
Significantly, an owner of a life insurance policy can exchange that policy for another life policy or for an annuity without an event of recognition under the U.S. tax laws as a Section 1035 exchange. Similarly, an owner of an annuity can exchange that annuity for another annuity without a tax consequence under Section 1035.
Unfortunately, the owner of an annuity cannot exchange for a life insurance policy without an event of tax recognition under Section 1035. Instead, the annuity holder would be taxed at ordinary rates on the difference between his tax basis in the annuity and the proceeds of the annuity.
Thus, there is need for a method or system that is an annuity at the time of creation, but will convert automatically, and without further election on the part of the owner, into a variable universal life insurance policy at a specified date in the future.
At the time of the conversion from an annuity to a life policy, the amount of mortality insurance will be significantly less than if the product had been a life insurance policy from the outset. Further, there is a build up of investment income with which to pay for the mortality charges.
The reason for the automatic conversion is to avoid the unfavorable tax treatment associated with an exchange of an annuity for a life policy.
Various examples of financial planning methods are found in the prior art as exemplified by the following patent.
U.S. Pat. No. 6,064,969 describes an investment system including a computer implemented annuity system generating annuity proposals for customers comprising a memory storing customer information input from a customer and annuity information and a processor to retrieve the customer and annuity information from the memory and generate an annuity proposal responsive to the customer and annuity information. According to the annuity system, the annuity proposal includes one of the fixed period installments, life, joint and survivor, joint and contingent and proceeds at interest annuities. The proceeds at interest annuity may also be viewed as a flexible certificate of deposit investment proposal for use by companies providing banking services.
U.S. Pat. No. 4,750,121 teaches a pension benefits system for enrolled employees comprising a trust institution and a life insurer institution where the trust institution receives periodic payments, purchases and retains a life insurance policy from the life insurance institution covering each enrolled employee, invests in available securities, provides specific accurate future projections of periodic benefits, receives all life insurance policy proceeds upon the death of each enrolled employee and distributes all periodic payable benefits.
U.S. Pat. No. 4,969,094 relates to a self-implementing pension benefits system for subscriber employees including a life insurer institution and a lending institution. The life insurer trust institution computes and receives each subscriber employee's periodic payment primarily upon each subscriber employee's age and desired periodic benefits and issues a life insurance policy covering each subscriber employee providing specific accurate future projections of periodic benefits for retirement, death or disability; and distributing all life insurance policy proceeds upon the death of each enrolled employee to the lending institution.
U.S. Pat. No. 6,161,096 describes a method for a deferred award instrument plan by identifying at lease one participant in the deferred award plan, retrieving financial data related to stock options corresponding to the identified participant, computing a spread associated with the retrieved stock options, establishing a trust with the spread, determining whether a life insurance policy has been purchased by the participant, determining whether a split dollar agreement has been executed, monitoring and paying at least one premium for the life insurance policy and notifying the participant that a payment associated with the life insurance policy has been paid.
A study of the prior art illustrates the need for a flexible financial estate program or plan capable of maximizing return on capital that minimizes the tax consequences and associated increased charges.